Public Accounts Committee - Minutes of EvidenceHC 406

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Oral Evidence

Taken before the Committee of Public Accounts

on Monday 3 March 2014

Members present:

Margaret Hodge (Chair)

Mr Richard Bacon

Guto Bebb

Jackie Doyle-Price

Chris Heaton-Harris

Meg Hillier

Mr Stewart Jackson

Austin Mitchell

Nick Smith

Ian Swales

Justin Tomlinson

________________

Amyas Morse, Comptroller and Auditor General, National Audit Office, Gabrielle Cohen, Assistant Auditor General, NAO, Vikki Keilthy, Director, NAO, and Marius Gallaher, Alternate Treasury Officer of Accounts, were in attendance.

REPORT BY THE COMPTROLLER AND AUDITOR GENERAL

Infrastructure investment: the impact on consumer bills (HC 812-I and II)

Examination of Witnesses

Witnesses: Bronwyn Hill, Permanent Secretary, Department for Environment, Food and Rural Affairs, John Kingman, Second Permanent Secretary, HM Treasury, Geoffrey Spence, Chief Executive, Infrastructure UK, HM Treasury, and Simon Virley, Director General, Markets and Infrastructure Group, Department of Energy and Climate Change, gave evidence.

Q180 Chair: Welcome. Sincere apologies, because we probably mucked you around last time in a way that we try not to do. My apologies.

I will ask each of you this question, but I will start with you, Mr Kingman, as you are sitting in the middle. Do you think that you are responsible for considering the impact of infrastructure investment on consumer bills?

John Kingman: Yes, across the piece, absolutely. The Treasury cares a lot about infrastructure and it cares a lot about consumer bills. We have an oversight of all of these important sectors, some of which are described in the Report, and if you asked our Ministers, they would absolutely want the Treasury-as it does-to see itself as having that overview and as taking a close interest.

Q181 Chair: How does that impact on the way in which you determine infrastructure investment, on how you oversee it and then perhaps on the view you take of subsidies?

John Kingman: It varies enormously between sectors, because the characteristics of different sectors are different and because the respective roles of what is funded by consumers and taxpayers varies between sectors. If I take the energy sector, for example, it is well known that there has been a very lively debate between ourselves and the Department of Energy and Climate Change about a whole set of things that that Department would like to do. We see ourselves in that kind of debate as being very concerned to get the right answers for the economy and for consumers and to get costs down.

Q182 Chair: The reason I turned to you is because you have this oversight across Departments from the Treasury, and the whole tenor of the Report is to say that there is a failure by Government to assess the impact on consumers. I know you have written to me, and your letter to me suggests that you are shoving it off to other people. I am really very anxious to hear from you not a broad answer, but a focused one. Let us focus on energy, because that is the most important part of this Report, although we could have a discussion about fares and rail infrastructure. Let us focus on energy: over the next decade, two thirds of the infrastructure investment will be in energy. Which? reckons that the impact on bills will be £740 per annum, which we think is probably not far off. How does that impact on what you think of the level, the pace, who pays and the oversight? It is those sort of issues and the subsidies.

John Kingman: I fully agree, but let me just be quite clear first. There is a difference of view between us and the NAO on the specific proposal in its report that we can sensibly aggregate a set of different things across sectors; I am happy to talk about the ins and out of why we disagree on that, but we do. However, I would not want you to read into that that we do not care about the cost to consumers of infrastructure, and indeed other costs to consumers, in all these deregulated sectors; they are very big sectors. As the report rightly describes, outside communications, the bills are going up, for a combination of reasons, some of which are to do with new infrastructure.

If you take the case of energy, we have a large team in the Treasury. If you were to draw a sort of pie chart of how the Chancellor spends his time, you would see quite a significant slice is spent on energy policy, and he is concerned about exactly the things you describe. He is concerned to keep the lights on, but he is also concerned to keep the costs to consumers down.

Q183 Chair: Okay. You care, and you have a large number of people. Is it the view of the Treasury, and therefore the Government, that it is fair that an extra £740 per annum-the Which? figure, if we can accept that as being broadly correct-is the extra bill that consumers should pay, simply-this is nothing to do with world energy prices-to pay for the infrastructure that previous generations have failed to invest in?

John Kingman: Can I ask Simon to comment on the figure-

Q184 Chair: Is it fair? Do not take the figure too seriously. We can take the 18% in real terms, which the NAO talks about. It is around £740. Is that fair? Are you happy with that? You take responsibility for it. Is that where we should be?

John Kingman: What we have to accept with energy policy is that, first, there are real problems with ageing infrastructure that needs to be replaced-

Q185 Chair: We understand all that. I am asking you a specific question. Somebody in Government, and you are sitting there in the Treasury, has got to take responsibility for the impact of all this on consumers and decide the pace, what is built, who pays, and those things-whether it should be the consumer or the taxpayer? That is you. Are you happy with the impact that this has on consumers? Do you think that is fair?

John Kingman: We are never happy to see bills going up. We think-

Q186 Chair: So what are you doing about it?

John Kingman: We are doing a lot to drive down the cost of infrastructure, and Geoffrey can talk about that. These are very difficult policy trade-offs in a world where both the last Government and this Government wanted to see serious progress towards decarbonisation. That is expensive and these are difficult policy decisions for Ministers, precisely for the reason that you give, namely that these things are expensive and that their cost will fall on consumers-

Q187 Chair: Well, it is your policy, Mr Kingman, that these other people are setting about implementing. If you, as the central Government-[Interruption.] It is Treasury policy. It is not your policy personally. It is Government policy but the Treasury has oversight of it. It is your Department. I am just asking a simple question: do you think it is fair to the consumer that they should pick up the tab for the total cost of this infrastructure, which the NAO says is about 18%, based on DECC figures? Alternatively, Which? tells us the cost is £740 per annum.

John Kingman: By definition, I work for the Government so everything the Government do must be fair and right, but in practice on energy policy all the things you describe reflect a series of trade-offs that are struck in complex discussions between our Department and the Department of Energy and Climate Change, and central to those policy discussions-invariably, in my experience-is the cost to consumers and the economy. That is played through in every one of the decisions that drives that cost.

Q188 Chair: The problem is that because you do not look at the overall picture-we will come to the argument with the NAO in a minute-we are then left either with crises, where consumers feel that their interests are not being protected by the Government, or you come in with a late unthought-through subsidy to try to deal with the political problem of a consumer revolt.

John Kingman: I would be the last person to downplay the difficulty of these policy decisions, but I do not think that we feel it would be reassuring to consumers, or the right answer, for us to somehow say to ourselves, "Well, maybe it’s OK that energy prices are going up, because broadband prices are coming down and it all comes out in the wash." We just don’t see it like that. We are very concerned about the costs that are falling on energy consumers, and that has informed all of our policy work in the area.

Q189 Chair: Let me go through everybody. I haven’t got as far as I want, but I want to give the others a chance. Mr Spence, do you see that you have a responsibility, in overseeing the infrastructure, to look at the impact that it has on consumer bills?

Geoffrey Spence: Yes, I do, with a particular focus, though, which is where IUK sits within the Treasury, which is to deal with costs. Whenever we think of costs, we think of the underlying costs of new infrastructure being provided as part of the Government plans. That is something that we do see from a macro point of view, but we have to engage with the rest of the public sector and industry to reduce the cost of the investment going forward.

Q190 Chair: Do you think it is fair that consumers are being asked to pay all this money on their energy bills for infrastructure? Are you happy with that?

Geoffrey Spence: That is a decision that has been reached by Ministers over several Parliaments.

Q191 Chair: What do you do? What does your bit of the world-Infrastructure UK-do? There seems to be very little evidence. We will come later to how you control the capital investment, but, from the Report, it does not seem very well controlled, from the cost of capital through to the actual oversight of the contract, through to then actually seeing whether they have delivered what they said they would deliver. On none of those things does it seem that you have a very strong handle on trying to do your best to drive down consumer bills.

Geoffrey Spence: We focus on three things. First, we work with industry and the public sector to reduce costs, by which I mean the cost of construction. We look at the technical standards, and, in some cases, work with the private and the public sector to reduce the gold plating that is there. In the water industry, for instance, we work with the regulators and industry to get rid of the one-year hiatus in investment that actually puts up bills by about 2%. There is a periodic review, and the water regulator considers what investment should go forward.

We do other things, such as making sure we have a supply chain that can see what is coming in terms of investment, so it that can skill itself and organise itself and take advantage of that at a lower price in terms of the overall CAPEX budget. And of course we also try and ensure that things happen quickly in terms of projects actually coming to fruition; we help Departments to do that and help the MPA to supervise that, and also get finance at a cheaper rate for all the projects.

Q192 Chair: Let me give you one example of something I came across. It is in the water industry. I accept it is a few years back, but they underspent by £1 billion in one year. No doubt they had been given permission by the regulator or whoever to put up their prices on the assumption they would spend it. They did not spend it, and they then simply increased their dividend payments by £700 million relative to the previous year. Who in that scenario, for heaven’s sake, is looking after the interests of the people paying their water rates? We are seeing that becoming an increasing burden, particularly in London and the south-east.

Geoffrey Spence: I would have to go back and look at the specifics of the case, but it sounds to me as though it is a matter for the regulator.

Q193 Chair: In 2005-2006, the water industry underspent by £1 billion. This was accompanied by an increase of £700 million in dividend payments relative to the previous year. There was no drop in the water rates because they underspent. You, collectively, either as Departments or as Treasury or through the regulator had given them permission to raise their prices for consumers.

John Kingman: The case you have described-I do not know the details-falls squarely within the responsibility of the water regulator. That is its job.

Q194 Chair: Who is looking after the poor consumer, Mr Kingman? That is what we are trying to establish. My constituents cannot go to the water industry. They expect you as Departments, or through you the regulators, to protect the interests of the consumer. I asked Mr Spence the question because he was full of warms words about getting money spent efficiently and protecting the consumer. I was simply giving an example of where it did not happen. Keeping costs down is different from affordability. We are here to look at the affordability of this massive infrastructure programme that we all know we need, but is it affordable?

Geoffrey Spence: They are different, but if you can make things cheaper to build and quicker to implement, they will be more affordable for the consumer. We specialise in that angle.

Q195 Chair: But you do not look at the affordability. You look at the price, not the affordability. Energy is worse than water. Water is getting worse now, but the way in which energy prices have gone up-ironically, since privatisation, when they were all supposed to get cheaper-is unacceptable. That is why it has created such a political hiatus.

Simon Virley: May I pick up on that point?

Chair: Do you think that you are responsible? I am looking for someone who thinks it is their job.

Simon Virley: Keeping energy bills down is a key part of what DECC is trying to do. There are a number of ways in which we do that: action on energy efficiency to keep energy demand down, which helps lower eventual bills; working with the regulator to keep the cost of the network regulation down; and trying to reform the energy market so that we get the investment we need at the least cost to the consumer. Those are all things that we do.

You referred to the increase in energy bills over the past decade. Of course, the majority of that has not been to do with infrastructure investment, but because of the rising price of wholesale gas over that period, which has been the main reason behind the rise in energy bills that we have all had to face.

Q196 Chair: But Mr Virley, put yourself in the brain of any of our constituents, particularly the ones who are less well off. Over the past decade, the median income hasn’t gone up, but energy bills have gone up 44% in real terms. And what are those constituents faced with now? An infrastructure programme, which we need for economic growth and to keep the lights on-all things that the Committee recognises-but suddenly a further 18% or £740 on their energy bills. Doing it in that way just isn’t right.

For those in my constituency, or the constituency of any of us around the table, you are not looking after the affordability of all this to people whose incomes haven’t gone up, but for whom energy prices and water rates-if we focus on those two today-have gone up.

Simon Virley: As you know, every year we publish estimates of what we think are going to happen-

Q197 Chair: What’s affordable?

Simon Virley: Within that report, we show the distributional impact of our policies. It shows clearly that the bottom 30% of households in terms of income stand to gain the most from the overall package that we put forward, so the policies are not regressive in the way that I think you are implying. The total package that we put forward, because of the targeted measures in terms of the fuel poor, is progressive; the bottom 30% gain more-

Q198 Chair: Hold on a minute. You agree that energy bills have gone up by 44% in the past decade in real terms?

Simon Virley: Yes.

Q199 Chair: You agree that the cost of infrastructure will put another 18% or 20%-I think that is a DECC figure-in real terms on energy bills in the next 15 years?

Simon Virley: Yes. I think you referred earlier to the Which? figure, which is a nominal figure. We tend not to focus on the general rate of inflation, but the real increase. Yes, we predict that, in real terms, energy bills will rise almost under any scenario.

Q200 Chair: But median income-maybe Mr Kingman will tell you, because he will know it-has not gone up over the past decade, has it?

Simon Virley: Not significantly, no.

Q201 Chair: You also agree that the poorest decile of people spend a higher proportion of their money on energy.

Simon Virley: Yes.

Q202 Chair: And according to the Report you are still trying for 15% of their income.

Simon Virley: There is complete recognition of the severity of fuel poverty. There is a huge amount of work under way to address that. The point I was making was that there are a number of policies targeted at helping the fuel poor, which make the overall policy package less regressive than just having a flat rate.

Q203 Chair: I accept that there are things to tackle fuel poverty, but a hike in energy prices impacts poorer people more than the rest of the population, doesn’t it?

Simon Virley: That is true.

Q204 Chair: So what are you doing about affordability?

Simon Virley: Well, I mentioned some of the things we are doing in terms of trying to reduce energy demand, by helping people with energy efficiency, particularly targeted on the fuel poor; by trying to keep the cost of networks down, working with Ofgem; and by reforming the energy market with the reforms in the Energy Act, to try to get this infrastructure investment at the lowest cost to consumers. Those reforms will reduce the cost compared with previous policies.

Q205 Mr Bacon: May I check something? You said a moment ago that your proposals will make the effects of the infrastructure package "less regressive" than they would otherwise have been. Are you saying that they will be regressive?

Simon Virley: What I am saying is that we publish the impact estimates by decile of the total package of policies and the bottom 30% stand to gain the most from Government policies, because of-

Q206 Mr Bacon: My question was not who gains the most and who gains to a lesser extent. You used the phrase "less regressive". That sounds like you are saying-correct me if I am wrong-that it will be regressive, but that it will be less regressive for those groups. Is that what you are saying?

Simon Virley: Well, I think I am saying that it is actually a progressive package, because-

Q207 Mr Bacon: The difference between the two is very clear, and I want to be clear in my own mind. "Less regressive" and "progressive" mean different things. It could still be regressive, but less regressive than it would otherwise have been, had it not been for the changes that you talked about. I am asking: is it merely less regressive than it would otherwise have been, but still regressive, or is it progressive?

Simon Virley: The point I am making is that the overall package is actually progressive, because the lowest income earners stand to gain the most.

Q208 Mr Bacon: So they will be better off than they are now.

Simon Virley: I am talking about the impact of Government policy.

Q209 Mr Bacon: If it is progressive, they will be better off than they are now, won’t they?

Simon Virley: The impact of Government policy is progressive. Of course, if wholesale prices rise, energy bills go up and nothing else happens, that will hit lower income earners more.

Q210 Chair: So are you saying that the poorest 30% will not have to pay any of this 18% increase for infrastructure?

Simon Virley: No, I am saying that the total effect of Government policy, when you take account of energy efficiency measures, is progressive.

Mr Bacon: Right. It sounds to me like you are saying that it will be regressive, but not as regressive as it would otherwise have been.

Q211 Chair: Quite. Why don’t you just say that it will be less regressive?

Simon Virley: Because that is not what I think is the case in terms of the material that we have published.

Mr Bacon: Do you think that they will be better off than they are now?

Q212 Chair: Will they pay less than they do now?

Simon Virley: No, they will not be paying less than they are now-

Q213 Chair: Assuming no change in energy prices.

Simon Virley: But they gain the most in proportionate terms, compared with other deciles.

Chair: It must be less regressive.

Q214 Jackie Doyle-Price: To be fair, if our energy policy means that we are moving towards relying less on carbon and fossil fuels, there will be a step change in energy prices for the consumer and, as energy bills are regressive by definition, we are dealing with making things less regressive. But we have got to take it on the chin that energy prices are going up, because we are gradually pushing coal out of the system. Would you all accept that it is your job to try to do that at minimised impact to the consumer and to make it is as easy as possible to bring investment on stream that brings the lowest cost energy on to the grid?

John Kingman: Yes.

Simon Virley: Yes.

Q215 Jackie Doyle-Price: So what has gone wrong with Eggborough? We had a briefing on this and I am familiar with this-I bear the scars of negotiating with DECC to try to get investment in Tilbury. We know that biomass is a cheap source of fuel compared with other renewables, and Eggborough, which had this project in planning for a number of years, was ready to put shovels in the ground this year, but, at a stroke, policy changes last Autumn made that uneconomic. Eggborough tells us that losing that 4% of capacity on to the grid will raise consumer bills by £38, due to the capacity crunch and the need to move to other renewable technologies. What is your observation on that?

Simon Virley: The Government sets an overall limit, called the levy control framework, for the amount it is willing to spend in terms of low-carbon technologies, and we have run an open and competitive process to bring forward those projects that are affordable within that cap. Eggborough has qualified on the list, but it is not currently affordable, depending on the progress of the projects that have been rated ahead of it in terms of deliverability.

That is the current position. It could be that other projects do not go forward, in which case Eggborough may become affordable, but there is a limit in terms of the amount that Government is willing to spend in the form of the levy control framework. If we convert more coal stations to biomass, we will end up adding more to bills.

Q216 Jackie Doyle-Price: Well, we will end up adding more to bills anyway, and biomass remains the cheapest source of energy that can contribute significantly to the grid as compared with other renewables. If I read what you are saying correctly, it is effectively a competitive process. It is very difficult to encourage companies to bring forward investments of many hundreds of millions of pounds without that certainty. We are talking about a project that was in with planning for four years. As far as they were concerned they weren’t going to be putting shovels in the ground this year.

Simon Virley: If we didn’t have some sort of competition between the renewables projects for the limited budget available, I am sure that this Committee would have something to say about it in terms of not driving competition between technologies and between different projects. We are trying to deliver the best value for the consumer, as you rightly said in your introduction, to make sure that we keep bills down as low as possible. That means we want to encourage competition between these projects.

Q217 Jackie Doyle-Price: In terms of the projects that were successful in the competition, what proportion of energy generation will they bring on if they all deliver as you anticipate?

Simon Virley: Off the top of my head, I think it is something like 5 GW, in terms of the projects that have qualified under the affordability cap.

Q218 Jackie Doyle-Price: What is that as a percentage? Eggborough are telling us that their loss is 4% of capacity.

Simon Virley: That would be about five-ish per cent.

Q219 Austin Mitchell: Given that, in effect, infrastructure investment is a balance between public spending, which is one third, and private enterprise companies spending two thirds, it seems to me that we have had a comparatively benign period in which Government has been able to reduce taxes and the private sector has gone easy on infrastructure investment. We now have a creaking infrastructure, so the chickens are coming home to roost and we have some backlog to make up.

I am amazed at the Treasury. The letter from you, Mr Kingman, seems to me an attempt to obfuscate the issue by saying that it is all very difficult, there is no typical consumer, there are different kinds of investment-there is this, that and the other. Surely-I think this is what is important to us-you can predict the effect of the increased burden of infrastructure investment on the most deprived and vulnerable groups in terms of the affordability of bills. That is the real concern. You can predict, after every Budget, what is going to happen to the widow with her mite, and what will happen to families with kids. Why can’t you tell us what the effect will be on vulnerable groups of this increased infrastructure investment that is going to come?

John Kingman: First of all, let me say that I agree with your characterisation of broadly where we are in terms of the backlog problem. You are right about that. The specific disagreement between ourselves and the NAO is about what you can do in different sectors and how far you can add them up. As the Report rightly describes, in the energy sector, DECC publishes long-run forecasts-the impact on average households and so on-and Bronwyn can talk about what it is possible to do in water.

Once you get beyond those sectors, however, it gets an awful lot more complicated. In the communications sector, the kinds of uses that different kinds of consumers make of communications technology vary incredibly widely. When you get on to transport-the Report has really very little to say about transport, which is a huge driver of infrastructure cost to both the consumer and the taxpayer-it gets an awful lot more complicated.

For example, the biggest single investment proposition that we have to face up to is meeting the cost of High Speed 2. I don’t know exactly what the fare policy or the impact on fare-paying passengers of High Speed 2 will be, but I am pretty sure that adding that on to something for the typical water-using household does not give you a terribly meaningful result. Or take the big renovation of parts of Heathrow-that is a big infrastructure project with a big cost. That cost will fall on landing fees to airlines, which in turn will flow through to consumers, but I am not sure I would want just to add that on to what you get the typical household to pay in their energy bill or their water bill.

The point I was making in my letter-I apologise if it came across as in any way obfuscatory-was just that it is different between different sectors, and the notion in the NAO Report that we can just add it all up is one we do not agree with. There may well be things we can do better in individual sectors, in terms of publishing more information, collecting more information or asking the right questions-it is a perfectly legitimate area of debate-but we do not buy the idea that you can just add it all up.

Q220 Austin Mitchell: Difficult as it is, this is the nub of the problem, isn’t it? What can the vulnerable consumer bear in terms of an increase in bills to improve an infrastructure which you have allowed to degenerate?

John Kingman: As I said, if you take an individual sector-water or energy-people should absolutely have the data and the understanding of how to make that trade-off, but I do think it is rather different if you are looking at how the costs of Heathrow terminal 2 were met.

Chair: Mr Kingman, this is such nonsense. Just think about anybody doing work on cost of living or inflation. You take a basketful of goods, you look at them and you assess in a crude way what that means about what is happening to people’s cost of living and inflation. All that is being asked of you-I tend to agree with you about leaving communications out of it, because that goes up and down like a yo-yo, but if Government action is going to impact people’s ability to keep warm, have fresh water, travel to work and other very basic things, Government has got to have some notion across the different groups within the population of the collective impact of all those policies on individuals’ standard of living. It is not beyond the wit of man. It will not be perfect, but it is not beyond the wit of man to make sensible guesstimates and estimates which will then inform policy.

Q221 Mr Bacon: I think you have excelled yourself, to be honest. I think you have spent too long in investment banking thinking up clever wheezes. Frankly, the idea that because you would not add the costs of HS2 to the typical household water bill, you cannot come up with some intelligent information on what it would cost to fill a bath with hot water or fill a kettle and make sure it was boiling before you made your tea is as specious an argument as I have ever heard. Plainly, the costs of HS2 have got nothing to do with it. You might as well say, "Well, we wouldn’t add in the costs of our deployment in Kosovo and Operation Telic in Iraq, because it wouldn’t really be valuable information when it came to trying to work out the overall impact on utilities for the average pensioner couple over 65 in Essex."

It is just not a sensible discussion, frankly, Mr Kingman. It really isn’t. There are things that you could do. We all realise there is no such thing as the typical household, which is why you would have to have a series of different typical households-a family with small kids, a family with adults who go out to work, a pensioner couple and so on-but for basic utilities like energy and water, there is more you could do than you have done, isn’t there?

John Kingman: I fully agree that this is much more doable in the energy sector and the water sector. Bronwyn should talk a bit about what we think is doable in the water sector. The Report-correctly, I think-describes energy as closer to best practice in terms of what is done. The Chairman has agreed that communications is a bit different; I would argue that transport is very different. High Speed 2 is an enormous project. What do we do about that cost in this aggregate that we are asked to produce? This is not something that we feel comfortable just tacking on.

Vikki Keilthy: I would just like to challenge you on communications. Arguably, communications is an essential service. Certainly we do not all have to have smartphones and super-fast broadband, but there is a basic level of service which increasingly we all need, for our daily lives and to engage with Government. Therefore, I think that it ought to be in some way. Perhaps it needs to be modified because of the pace of technology, but in some way, communications, as an essential service, should also be alongside energy and water.

John Kingman: It is a very important sector, and what is happening in that sector has been a lot more benign for consumers than elsewhere. I think it would be very difficult to capture what the typical consumer has to pay for. I also think that if we came to this Committee and said, "Look, it’s okay about water and energy because the cost of broadband has come down a lot," you would send us away with a flea in our ear.

Q222 Chair: But Mr Kingman, when you make decisions around tax, you look at the impact of tax changes on the population, don’t you?

John Kingman: Yes, but precisely on that point, there are many tax issues. In the Budget document, we will publish distributional analysis, which captures the impact of the main tax measures, but there are all sorts of tax measures that impact on relatively small numbers of the population that we do not include in those calculations. That is the point I am making.

Mr Bacon: But you publish lots of information about them, so that you can pick up your Daily Mail- [Interruption.]

Amyas Morse: I am sure this is not going to surprise Mr Kingman at all, but if you look at something like transport-you can do this with anything else-there are specific projects, and then there are things that drive general costs of living, such as distribution costs and so forth. If you went to road transport, you could make a distinction between the two. None of this is beyond the wit of man; and the reason for proposing this is so that when decisions are being made in future about other infrastructure decisions to be priced on to the consumer, they are made with information rather than in a state of not having that information, and they are made with a degree of visible accountability. It does not require that every single thing that can be classified under a heading should therefore all be consolidated. I think you could produce-you could have produced by someone; we did not even go as far in the Report as to say who should do it, but it needs to be sponsored by yourselves, I think-something that would give a meaningful holistic number for particular groups of what there is likely to be.

John Kingman: I am pleased you say that, because we have discussed precisely this issue, thanks to this Report, with the UK regulators’ network, and they have agreed that it is probably a sensible thing for them to have a think about.

Q223 Chair: They have agreed what?

John Kingman: They have agreed that this would be a sensible question to have a think about, but they are as aware as we are of the problems. I just do not think that Ministers are going to be up for publishing numbers unless they believe those numbers really mean something. I think Ministers are very interested in the drivers of cost in the individual sectors; and they are rightly very demanding of officials on that. The Report makes some very sensible suggestions about ways in which we can improve the way we collect and publish information in the individual sectors. I am afraid we are not yet persuaded there is anything robust we can publish that adds it all up.

Chair: I think that is pretty shocking, because in the end it all lands on the consumers. Our constituents are then being forced to pick up the tab that you have not thought about. You have not thought about the impact collectively, but you are expecting them, in very hard times, just to foot the bill, and that is a shocking thing. It may not be a perfect figure that you come out with; it may be an indicative figure; but you can do it, and you are choosing not to, and that is pretty shocking.

Q224 Nick Smith: I want to pick up on that point. Back in Blaenau Gwent in south Wales my constituents are furious. Listening to your argument today is like wading through mud. If you look at figure 8, on page 27 of the NAO Report, and you look at the table on assessing the future affordability of bills, nowhere in the energy, water or telecoms sector is there an attempt to look at the effect of these increases on vulnerable groups. It just doesn’t wash. Everybody knows the world is complicated; everybody knows it is fast changing; but because you can do this other macroeconomic analysis, they want to know that you, the Treasury, can do a good job on this and co-ordinate this in the future, to understand what is happening for their household bills every year.

John Kingman: Let me make it clear: we fully agree that there are improvements that can be made. It might be useful to hear from Bronwyn about the things that are going to be done in water.

Bronwyn Hill: Shall I enlighten the Committee?

Q225 Nick Smith: It would be good to hear about water, but the same people who find it hard to pay their electricity bills will also be the same people who find it hard to pay their water bills, so we need to know what is happening for low-income groups across the piece-not just different sectors. That is why we need you to get your act together.

Bronwyn Hill: Just to set the context for water, obviously water is a price-regulated sector, so Ofwat has the primary responsibility for looking at water companies’ plans on a regional basis and determining over a five-year period what the price cap is for the average bill payer in that area. So clearly they need to be very interested to see-

Q226 Chair: Do you need to think about affordability? Not them-I think you do, on behalf of the consumer. Who is thinking about affordability? They set the price. Who thinks whether it is affordable?

Bronwyn Hill: What I am trying to say is that what Ofwat told you a bit about at the last hearing you had with them was that they require the companies to engage with their customers about affordability issues, and they also speak to their customers about what their priorities are; so as well as bills and affordability, which is clearly a very big priority for people now, people are also very concerned not to be cut off. I caricature it as hosepipe bans. Nobody wants hosepipe bans, which we have seen. No one wants their house to experience sewage flooding. So customers want both needs addressing and they want cheaper bills. Why wouldn’t they?

Q227 Mr Bacon: Can you just clarify something? Paragraph 2.5 refers to the strategic review your Department did following the Gray review, and states that the review "does not specify whether Ofwat is expected to forecast future bills, or report on current or future affordability." Are you saying that is now wrong?

Bronwyn Hill: I am not saying that. That reflected what the Gray review recommended.

Mr Bacon: I am talking about the policy that you published following the Gray review. I am just asking if the sentence is now wrong because you have done something else to the policy that we do not know about.

Bronwyn Hill: No.

Mr Bacon: So it is correct.

Bronwyn Hill: I think there is a difference between taking account of the impact of businesses’ investment plans on what customers can afford, and then deciding what you can do about it. That is slightly different from modelling future forecasts.

Mr Bacon: I am just trying to find out if the sentence is correct.

Bronwyn Hill: Which sentence?

Mr Bacon: "It"-the strategic policy that your Department published after the Gray review-"does not specify whether Ofwat is expected to forecast future bills, or report on current or future affordability." Is that sentence correct?

Bronwyn Hill: I don’t know if it is correct in the sense that-

Mr Bacon: You don’t think it is correct?

Bronwyn Hill: I am saying that it was silent on the specific question, so it is correct.

Mr Bacon: So the sentence is correct because it is silent. That is what you are saying. Okay.

Vikki Keilthy: May I just quote what the document says? It says, "Ofwat shall, as a matter of priority, keep under review whether companies are taking sufficient action to have a measurable positive impact on the needs of those customers that may struggle to afford their charges."

Mr Bacon: Indeed, and that is quoted in paragraph 2.5 as well.

Vikki Keilthy: That is not the same as reporting on affordability.

Bronwyn Hill: If you will allow me, I will come on to what we are doing about modelling affordability, which I think is the question.

Q228 Mr Bacon: The last sentence in paragraph 2.5 says, "Nor is it clear whether it is Ofwat’s role to determine what is affordable."

Bronwyn Hill: I was coming on to that, if you will allow me. Ofwat has done some modelling in the past. It did it in 2006, and DEFRA updated that modelling in 2011. It is not as good as we would like it to be, which is why we are going to do further work to develop the underlying models. That aim to forecast longer term affordability-so, up to 2030. And at that stage-this is in 2011-informing a water White Paper, we said-

Q229 Mr Bacon: Informing what? Can you speak up?

Bronwyn Hill: A water White Paper. In the water White Paper we said, broadly speaking-and it is a model that needs improving-that we expect the increase to be 14% real between then and 2030. We have since said that we accept that once Ofwat has concluded price setting for the next five years-that is between 2015 and 2020-which it is in the process of doing now, we, Ofwat, with the Environment Agency, need to look together at all the factors that influence affordability in the water sector. To go back to what was said earlier about energy, we have similar issues-population growth, climate change, etc.

Chair: We understand that. No one is querying that, but the only thing I would say to you is that you haven’t got a capital programme that goes beyond 2015 yet. I want to get back to Nick.

Q230 Mr Bacon: Before we lose the point, Chair, I was simply trying to find out where responsibility for determining what affordability is sits. I think I heard you say, "We and Ofwat together have to work on it." Is that correct?

Bronwyn Hill: In terms of modelling, future forecasting of impacts-

Chair: Why don’t you just answer the question?

Mr Bacon: Where does it sit?

Bronwyn Hill: I am trying to answer the question. I think the question works in two ways. Policy responsibility sits with DEFRA and we have a series of measures to address affordability concerns for people who struggle to pay their water bills, which I can describe, if you’re interested. They were not the subject of this Report, to be fair to the NAO. They were set out in the water White Paper. Ofwat‘s role is very important because it looks at the efficiency, innovation and the cost of capital of the individual water companies, when they present their business plans.

Q231 Chair: So you decide whether Ofwat’s capital programme is affordable?

Bronwyn Hill: I am trying to explain. With most of the capital investment in water-if you look at the NAO Report, you will see a little pie chart towards the end. I think it is in appendix 3. If you look at that, you will see that 50% of what is spent that is reflected in customers’ bills is maintenance and renewals-maintaining and renewing the assets.

Chair: We understand that. Who decides whether it is affordable? That’s all. Who decides? That’s a cheek, anyway, doing that. We will come back to that. Who decides whether it is affordable?

Bronwyn Hill: I think the question is that the Government have responded to concerns about affordability with a series of-

Chair: No.

Mr Bacon: No. It would be really helpful if, when you are asked a simple question such as who determines what is affordable, you don’t answer it with "I think the question is".

Bronwyn Hill: Let me try to explain. We haven’t set affordability targets.

Q232 Mr Bacon: If the question is who determines what is affordable, the answer is either an institution-DEFRA or Ofwat, or both-or "We haven’t decided". The answer has to be an institution of one kind or another, or "I don’t know".

Bronwyn Hill: With respect, there is no affordability target in the water sector.

Mr Bacon: So the answer is that you don’t decide. That is a good answer. It is not necessarily that people will differ-it is a clear answer. The answer is that you don’t decide.

Bronwyn Hill: There is no target for affordability.

Chair: That is shocking.

Mr Bacon: That is a clear answer. Thank you.

Q233 Nick Smith: I want to go to a related point on page 27, figure 8, and the failure to look at vulnerable groups across the piece. Low-income households like those in Blaenau Gwent spend about 15% of their total expenditure on energy and water bills. For the rest of us-for all households-it is about 8%. Low-income households’ income fell by 11% in 2011. This is a question for all of you. How do you plan for the cost of policies to reduce the impact of rising bills if you don’t know how many consumers are likely to struggle to pay?

Simon Virley: Shall I kick off? As figure 8 and the Report make clear, DECC has produced estimates of the impact on different groups and has produced-

Nick Smith: On fuel poverty.

Simon Virley: On fuel poverty.

Q234 Nick Smith: On low-income groups across the piece?

Simon Virley: We do produce distributional analysis each year by decile, so the effects of Government policy are published in our prices and bills report.

Nick Smith: Vikki, do you want to jump in on that?

Vikki Keilthy: They are, but not for future affordability. We are looking at the right-hand side of figure 8. For future affordability, you are not identifying what the impact will be for vulnerable income groups.

Simon Virley: I would take issue with that description because our March 2013 prices and bills report actually has the effect of Government policy in 2020 by decile. So the figures are there and published. They are sitting in front of me.

Vikki Keilthy: So when this was agreed-this is a cleared Report, and we are talking here about forecasting fuel poverty through to 2027-it is correct to say that when you are predicting fuel poverty through to 2027 you are not disaggregating that by decile.

Simon Virley: I have the chart in front of me from our publication last year that has the impact of Government policy by decile to 2020.

Vikki Keilthy: That is about bills not affordability. You are predicting bills; you are not talking about whether those groups can afford the bills.

Simon Virley: As you know, we have produced publications. We have done a forecast now for the number of households in fuel poverty, out to 2022, both with and without Government policies. That obviously gives an indication of the challenges that some of your constituencies face.

Q235 Nick Smith: So it is fair to say that you are probably going in the right direction but are not absolutely answering the question. What about the rest of you?

Bronwyn Hill: With regard to water, as the Report says at paragraph 2.22, Ofwat has published some detailed analysis of affordability and I think has provided some evidence to you following-

Chair: Would you mind speaking up? I am sorry, but the acoustics are awful.

Bronwyn Hill: In paragraph 2.22, there is a reference to work that Ofwat has previously published. I think it provided that evidence to you in its follow-up to the previous hearing. In terms of forecasting the effect on different groups, we would have to look at the work we are doing to develop our modelling to roll that forward beyond a five-year period.

Q236 Nick Smith: You have done it in the past-sort of-but you haven’t done it for the future?

Bronwyn Hill: Correct.

Q237 Nick Smith: Anybody else want to add anything?

John Kingman: My sense is that energy and water are the sectors that the Committee is most concerned about. Tell me if that is incorrect. Telecoms is obviously very different and transport is not covered by the Report. So, I don’t think I have much to add.

Q238 Mr Bacon: It is because it’s of most concern to our constituents. You might be able to choose not to take a train journey-not to travel. You might be able to choose to spend less time on the phone.

John Kingman: Indeed.

Mr Bacon: But you have to use water and you have to keep warm.

John Kingman: Exactly. We agree.

Mr Bacon: Good.

Nick Smith: My constituents also need to travel, so the transport sector would be important.

Chair: Yes, transport is important. In a way, we could come back and do this on transport. To me, that is a much bigger sector than communications.

Q239 Guto Bebb: I want to go back to the Eggborough situation just to clarify something. I’m concerned; I just want to understand the explanation given. My understanding is that there was a change of policy a few weeks before the final decision was made, which resulted in what was previously expected to be a project included in our plans being excluded, so can you just clarify this? Was there a change of policy and, if so, what was it? My understanding is that they moved from the issue of speed of delivery and least cost, into trying to ensure a balance across sectors.

Simon Virley: The framework, in terms of how those projects were going to be assessed, was published in the middle of last year. That has been transparent all the way through. We have of course been mindful of the impact on consumer bills, as I said in the answer to the previous question, so there is a limit to how many of these renewable energy projects we can fund, and it is against the published criteria that we have assessed the projects and come up with the ranking that we have.

Q240 Guto Bebb: In terms of the range of technologies, what would you classify as a range? Would you say that renewables would be one policy area?

Simon Virley: No, there are sub-divisions within that, in terms of trying to ensure that we have a mix of technologies, in terms of the deliverability of baseload power as opposed to intermittent technologies such as wind.

Q241 Guto Bebb: So when these decisions were made, to what extent was the impact on consumer prices taken into account? We have heard evidence from another member of the Committee that there is likely to be an increase in cost to the consumer as a result of the loss of Eggborough. To what extent was that part of the decision-making process?

Simon Virley: We published, back in November 2012, the limits for the levy control framework, which sets the support that the Government are willing to give to low-carbon technologies, including renewable energy projects. That limit has been known about by industry for well over a year now.

Q242 Guto Bebb: But in terms of individual cases, there wasn’t any consideration of the cost to the consumer in individual decisions.

Simon Virley: Implicit in that is an assumption that Eggborough will close. That is obviously a matter for them to decide, in terms of how they progress. Obviously, that will depend on the situation in the market and is a commercial decision for them.

Q243 Guto Bebb: My concern is actually on a wider basis. In the same round, we seem to be supporting energy options that are more costly than the ones that were rejected. If there was a concern for the consumer, why would we be supporting options that are more costly than Eggborough, for example? Why would we do that if there was a concern about the consumer?

Simon Virley: Because we have to look not just at today’s costs, but at what costs technologies might have in the future. Energy obviously has a long lead time in terms of investments. We have some stretching and ambitious carbon reduction goals. And technologies can reduce in cost over time. The offshore wind industry, for example, obviously costs a lot in terms of offshore wind at the moment, but the industry itself has committed to reduce those costs substantially over the next few years.

Q244 Guto Bebb: Has there been analysis of the impact on consumer prices of those reductions?

Simon Virley: Yes, because that is captured within the forecasts we have for the levy control framework.

Q245 Guto Bebb: This is my final point. Obviously, there is a lot of talk about the need for long-term decision making that reduces carbon emissions and so on, but thus far, in the past three or four years, what has been the impact on UK energy capacity in terms of the use of coal? Has it gone up or down?

Simon Virley: Coal, in terms of its percentage, has been rising recently, because market signals have been very strong for coal, so coal plants have been doing rather well recently.

Q246 Guto Bebb: The question I would ask, then, is this. Regarding the aims of policy and the effect of policy on consumer prices, to what extent are we taking action that seems to be undermined by the realities of the market?

Simon Virley: The watchword I would give you is diversity. In a sense, we want to have a spread of technologies, because we do not want to have all our eggs in one basket, so we try to make sure that we have a diverse range of technologies available to ensure Britain’s energy supplies.

Q247 Jackie Doyle-Price: But does that interfere with the challenge you have with capacity, bearing in mind that some technologies will generate a lot more power than others?

Simon Virley: You are right to say that there is a double challenge. We have got to keep the lights on and try to change the mix to meet the Government’s targets. The unique nature of the challenge in the energy market means that it is a particularly difficult task over the next few years. All the coal plants that you are referring to are likely to come off the system over time because of European directives to do with local pollution control.

Q248 Jackie Doyle-Price: Do you worry about the capacity crunch at the end of next year?

Simon Virley: Yes, we do. We have published projections on the security of supply outlook, and we have been working extremely closely with National Grid and Ofgem to come up with plans-including the capacity mechanism, which is in the Energy Act 2013-to tackle those issues.

Q249 Jackie Doyle-Price: And what will be the impact of that crunch on consumer prices?

Simon Virley: It depends how it manifests itself. In terms of the possible impact on wholesale prices, if you can avoid the crunch by making sure that you have investment, wholesale prices will not need to peak. If you have a crunch, wholesale prices will peak.

Q250 Jackie Doyle-Price: Would you share with us what sort of percentages we are looking at for a wholesale price increase?

Simon Virley: We have published our estimates of the wholesale prices. We have a rising trajectory over the period to 2020 because of some of the security of supply issues. We have published estimates in our impact assessments of the costs of the capacity mechanism, which is one of the main measures designed to address the security of supply shortfalls.

Q251 Jackie Doyle-Price: I guess what I am trying to get from you, Mr Virley, is an admission that the challenge of investing in capacity because of coal coming off will have a material impact on consumer prices between now and 2020, because of the impact on wholesale prices, as much as anything else.

Simon Virley: It is fair to say that the tremendous challenge of the infrastructure investment that we have to see-the Chair mentioned that two thirds of the total infrastructure needs come from the energy sector-means that there is likely to be upward pressure on bills. We do not deny that; all our forecasts show that that is likely to be the case.

Q252 Ian Swales: I would like to build on that. Mr Virley, do you agree that it is important that future investors have certainty, simplicity and ease when they make their decisions?

Simon Virley: Yes.

Q253 Ian Swales: Do you equally accept the charge that with seven energy Bills in 10 years and constant updates of policy that is not the case? Investors looking at the market see an amazingly complex world, which is bound to affect both their decision making and the cost of proceeding.

Simon Virley: If you look at the record on electricity infrastructure investment, we have actually seen record levels of investment in electricity infrastructure over the past few years. We have seen £40 billion worth of investment since 2010 in electricity infrastructure.

Q254 Ian Swales: Would you say that that is to do with incentives in renewables? Is it mostly renewable energy?

Simon Virley: It is renewables, but there has also been investment in the transmission wires and the distribution network.

Q255 Ian Swales: I declare an interest, because in my constituency there are four potential power station investments right now, three of which are for fossil fuels. If you talk to all those investors, they will tell you that they feel like giving up because the system is almost impossible to deal with. There is the Department of Energy and Climate Change and we now have the planning infrastructure authority, which was originally formed to remove objections, but seems to have become a kind of self-serving bureaucracy. One project has been agreed locally and by the National Grid and has everything in place, but it is going to take a year just to look at it. That is happening right now. Given that competition is one of the things that will help to keep bills under control, what are you doing to make it easy for investors to get on and invest in this world?

Simon Virley: A central plank of the Government’s energy market reforms is to simplify the system of support for low-carbon technologies by giving a simple price for the output of those power plants. You are right to highlight the challenges that gas-fired power stations-if they are the fossil plants that you are referring to-have had. However, that is as much about the market signals-the market price of electricity versus the wholesale price of gas-as it is to do with any uncertainty about the policy framework.

Q256 Ian Swales: What about the specific issue of the Infrastructure Planning Commission? Have you looked at its processes to see how quickly it processes applications for power investment?

Simon Virley: I think the IPC has brought forward proposals to streamline its own arrangements and give investors decisions on a quicker time scale.

Q257 Ian Swales: Brought forward proposals to whom? Surely that authority is supposed to be helping us to plan and make infrastructure happen, not get in the way.

Simon Virley: I think they have committed, in consultation with the Government, to giving those decisions within 12 months of receiving an application.

Q258 Ian Swales: Do you know what happens in each week and month of a 12-month process? Have you looked at the critical path? If a project goes into the process, do you know what is happening on each day for 12 months?

Simon Virley: I do not know about each day for 12 months, but we have looked.

Q259 Ian Swales: Maybe we should know each day.

Simon Virley: We have looked with the IPC at what can be done. Obviously, it needs to be a thorough process. The IPC is an independent body that makes recommendations to Ministers.

Q260 Ian Swales: It seems to be a body that has become something of self-serving bureaucracy. I know from a particular project in my constituency that has just entered the process that it is extremely simple. There is not a lot of work to do, but they won’t see any smoke at all until 12 months minimum, which is causing them problems opposite DECC’s capacity market process. Again, there are particular stages in that process, and if one bus is missed the next bus doesn’t come along for a year or more. Based on all the investors to whom I have talked-none of whom are the big six, which is an important point; we want to try to break the pseudo-monopolies. If we have people who want to invest, surely we should be making it as easy as possible for them.

Simon Virley: Yes, but I would note that 15 GW of gas farm has consent but is not being built because the market signals, as they currently exist, do not provide that incentive to invest. Obviously, part of the Government’s answer to that is to introduce the capacity market to make sure that there is a signal for that investment in new gas-fired power stations.

Q261 Ian Swales: May I ask another question on that area? DECC has done a lot of modelling, but is it modelling sufficiently the effects of intermittent power and the investment that is required to fill in the spaces in intermittent power? I have a bit of experience in the electricity industry, and one concern for consumers’ bills will be that the whole capacity market might look okay over a year but that on a given hour of a given day there might be a massive problem that potentially results in huge price hikes if intermittent power happens to be off at a time of huge demand. What is DECC doing to ensure that, in effect, the country is not held to ransom at times of low intermittent generation and high demand?

Simon Virley: I would point to two things. First, we are trying to ensure that we have a mix of technologies, as I referred to earlier. We do not want to have all our eggs in one basket, so we do not want to have just wind farms; we need to have a mix of technologies to make sure that we have a mix of intermittent and base load power available to us. Secondly, we are working very closely with the National Grid Company, which runs the system day to day, to get its technical advice on what levels of wind penetration it can cope with in operating the system.

Q262 Ian Swales: You have taken account of base load and intermittent, but have you taken account of the effects on both cost and carbon generation of cycling up and down large frame power stations to fill in what will be increasingly large holes in intermittent generation? Some startling figures are now emerging that show 40 GW gaps. Are you satisfied that not just the base load but the "switch on and off" capacity will be there to keep bills on an even keel?

Simon Virley: We have covered all of that in our modelling work, and we have published projections of what we need from peaking plants, such as gas plants, to be on the system and available for exactly the sort of scenario that you describe.

Q263 Ian Swales: Are you doing enough to encourage investment in that?

Simon Virley: A key plank will be the capacity market that we hope will run for the first time, subject to state aid, later this year. That is a key plank of the Government’s policy for making sure that the gas plant gets built, but as I have said one would expect the market to respond to the tightening margins that we are seeing, which should therefore feed through into spark spreads and the investability of gas.

Q264 Chair: I want to bring you back to the infrastructure that we are discussing this afternoon. We are dependent on the utility companies to run this capital investment programme, and you are still not clear whether it is affordable. Do you accept, Mr Kingman, that there is a bit of a tension between the prime interest and purpose of the utility companies and the interests of the consumer and Government?

John Kingman: I think there can be, although I think that the whole regulatory framework that has existed in this country for 30 years or so is precisely designed to try to find a way of aligning the incentives of the companies and their shareholders with the public interest.

Q265 Chair: That is clearly the purpose. Do you think that the current regulators in the areas we are talking about-in water with Ofwat and in energy with Ofgem-are fit for purpose?

John Kingman: Yes, I do, but there is always room for improvement.

Q266 Chair: Do you think that they are fit for purpose, Bronwyn?

Bronwyn Hill: Yes.

Q267 Chair: Do you think that yours are fit for purpose, Simon?

Simon Virley: Yes.

Q268 Chair: Why do we not have a fit for purpose test for those who run the utility companies? With the two that we are talking about, consumers do not have a choice. They have to have their water. You can talk about choice in energy, but it is not great. They have to have it, so why do we not do a fit for purpose test on those people?

John Kingman: Regulators have a significant set of powers, up to and including depriving a company of its licence, if they have any serious-

Q269 Chair: But they have never used that power, as we discovered last time.

John Kingman: I agree, but they have used powers that involve the threat of that-

Q270 Chair: But they have never used it, full stop.

John Kingman: They also have fines and all the rest of it. I think they have a pretty good armoury that has evolved over 30 years and delivered a lot for consumers.

Q271 Chair: It has certainly not delivered a lot on prices. Sorry to go over the history, but the history was that privatisation was supposed to deliver cheaper prices. If you look over the past decade, we can see the impact of the infrastructure proposals. You can hardly say that privatisation has delivered well for consumers, and we now have this question of whether the lights will go out. I cannot see that it has delivered.

John Kingman: I don’t know. If you talk to people internationally who follow these topics, they tend to see the UK regime as pretty good. They think that it is predictable, tough and that it does deliver.

Q272 Ian Swales: Should Ofgem have more control over business plans, investment and prices in the same way as Ofwat does over water? Ofgem only looks at infrastructure, does it not? Should it have more control over the other parts of the market?

Simon Virley: The energy market is different from water in the sense that there is a regulated monopoly part that is the networks, the transmission and distribution, and there I would support what John was saying: network costs have been reduced as a result of Ofgem’s actions. They do not regulate prices in the rest of the market. That is left to competitive pressure, and we have to try to ensure that we have maximum competitive pressure to keep those prices down.

Q273 Chair: Let me challenge you, Mr Kingman, on your claim that we are the envy of everyone. My understanding is that the UK is second only to Estonia among European nations for the number of people struggling to pay their energy bills. That hardly seems to me to be a record that anyone would want to emulate.

John Kingman: I have not seen those figures.

Q274 Chair: You should know them. I picked them up in something very close to the Report. Only Estonia, among European nations, has a worse proportion of people struggling to pay their energy bills. If you do not know that, that in itself says a lot about how we do not think about affordability when we do all these things, either in government or through the regulators.

Simon Virley: I have not seen the report you are referring to. I do know the price comparisons that we have, which I appreciate are not the same as affordability. In those price comparisons, the UK still has the lowest gas prices among the EU 15, and the fifth lowest electricity prices for domestic households. We still have low energy prices relative to other countries.

Q275 Chair: I think I must have got the figures from Which? Let me just deal with the capital issue. What matters a lot is how you set the cost of capital in determining something. You set a notional cost of capital, do you not?

John Kingman: The regulators, as part of their process, set a cost of capital, which they then use to set prices.

Q276 Chair: Okay, have either of you checked that against the actual cost of the last five years-DECC? Have you checked the notional cost against the actual cost?

Bronwyn Hill: DEFRA has not done that for water, but I know that Ofwat have been looking at it very carefully. They have recently published guidance on what they think the weighted average cost of capital should be for the next five years, which is lower than what the companies have in their business plans.

Q277 Chair: Have any of you checked actual against notional?

John Kingman: Not that I’m aware of.

Q278 Chair: That just makes me so angry-sorry about that, but it really does make me angry. If you look at Ofwat, you say, "Oh they’ve got these plans." Well, look at what Ofwat did-they allowed a cost of debt at 3.6% between 2010 and 2015, so United Utilities earns a windfall of £300 million over that period, because they actually got an index-linked loan from the EIB at 1.2%. Northumbrian Water are paying 11% on an interest on a loan that they got from some of their backers, so the consumer is ripped off, Bronwyn. You set these rates and then they are not the reality. You do not monitor them, and in the end, the consumer has to pick up the bill. It is outrageous that you do not monitor them. I can’t understand why you do not monitor them and then reflect it in the regulation.

John Kingman: In all seriousness, the whole point of RPI-X regulation, as it has developed in this country, is to create a period during which companies have incentives to make themselves more efficient, whether through the more efficient use of capital or cutting costs. They have a period during which they are allowed to receive that benefit and then, at the regulatory review period, prices come down to reflect that. In the US, they do not do that. They have annual reviews and the result is that you have much weaker pressures on companies to become more efficient, so there is a genuine trade-off here. Most people-

Q279 Chair: Mr Kingman, you are assuming that they are more efficient. What the evidence suggests to me, if I go back to Ofwat, is that they actually took it in bigger dividends. They did not provide greater efficiency. They just swallowed the money they made. This is so like PFI. When I look at it, it is just the same as PFI, where we sign these contracts up front, we are useless at getting the figures right, and then the people who actually deliver the contracts walk away, borrow money much more cheaply, and the consumer is left paying a bigger bill, whereas they get a massive profit, at the expense of the consumer.

John Kingman: If the system is working, and I am afraid I don’t know the details of this exact case, you have a powerful incentive for companies to find a cheaper availability of capital, and a regulator that comes in at the regulatory review and adjusts the cost of capital for that, so that customers, at that point, get the benefit. It is not a stupid system.

Q280 Chair: I have to say to you that that is a theoretical model. That is why, if you were actually monitoring what was happening in practice, I think you might find that it is different. The theory is that you say, "Okay, we’ll give you a generous settlement on what the cost of capital will be", and you think that will encourage them to go off and be efficient; I am telling you that the evidence demonstrates that they go off and just make massive profits out of it.

Bronwyn Hill: Can I just emphasise the point that John made, which is that Ofwat are very active on this point, because-

Q281 Chair: They are so active, Bronwyn, that they have allowed this massive windfall. So active. Brilliant.

Bronwyn Hill: Yes, but the price review for the next five years will enable all customers to benefit from that. Eleven companies are saying that they will have less than real increases. Some of them will be flat and only two companies, which have major-

Q282 Ian Swales: Building on the Chair’s comments, what do you do about the case you made earlier, where you have agreed a business plan and a price level that assumes a certain level of investment? Cost of capital is one thing, but just the capital itself is another thing. What do you do in cases like that? Is there some kind of clawback or penalty?

Bronwyn Hill: I think Ofwat explained last time that they can claw back if they need to, if they have discovered that companies have not delivered or have delivered for lower cost.

Q283 Chair: Can I just say to you that promising in the future is not the same as performance-what we are here judging you on-and what you have done to date? These are not newly privatised industries. These are industries that have been privatised for some time. We have quite a lot of experience of regulation. You can come back to me and say, "Ofwat are going to get it better in 2015", but they have made a hash of it between 2010 and 2015, which are the figures I am looking at. Looking at the record is precisely what this Committee should be doing, and you have allowed them to have cheap capital, which has increased their profits. You have allowed them to have access to capital that they have not used or spent, which has again increased their profits, and the consumer bill goes up. That is not a happy record.

Bronwyn Hill: As John has said, you either do it on a five-year basis-or longer, but I do not think anyone would recommend longer-or you chop and change every single year, which means that it is more difficult to attract the investment at low cost of capital.

Q284 Chair: I just don’t get it. The system is not working. I do not know how you can say that this is a working system.

Let me put something else to you. You have said that a lot of the capital expenditure goes on maintenance. Why do you allow that? That is another way for all the energy companies to increase prices, because they do it as capital investment so it becomes a cost of capital and, therefore, allows them a price increase. That is money that, if they were efficient, they should be simply setting aside from their revenue budget. Why allow them to capitalise it? It is a means of allowing them to increase the price and therefore get lazier about efficiency rather than smarter about efficiency.

Bronwyn Hill: I was referring to figure 11 in the NAO’s Report, which is not about the cost of capital so much as the overall expenditure. A lot of that will actually be revenue; it is not capital.

Q285 Chair: Half of it. Maintenance costs, page 15: half of the investment in its water is actually maintenance. Ian Byatt, the ex-director of Ofwat waxes lyrical on this issue: "Both Thames and its owners knew full well about the need to clean up London’s sewage network long before they took over the company. If they had followed a more responsible corporate policy, they would now have the capital resources to support investment." He says that Thames Water has been profligate in paying high dividends to shareholders in the past, and asks why they should be let off the hook. That is an ex-regulator saying this to you.

Bronwyn Hill: I think we are talking at cross purposes. I was talking about all water companies, as in the NAO’s figures. For example, Thames Water has invested in maintaining and replacing the Victorian pipes in London. If they did not do so, we would be seeing even more bursts and leaks than we already do. That is an important investment in maintaining the asset.

Q286 Chair: You are not really answering the question. Let me put the question again. Much of the capital investment is actually spent on maintenance. That is what the Report says on page 15. Half of the investment is actually spent on maintenance. If they get the money on maintenance, that gives them the ability to put a cost on capital and therefore put up their prices. We have talked about whether they get the cost of capital right, but I am now saying that what they include in that capital pot is not actually investment but maintenance. It should not be funded in that way, and it should not, therefore, lead to price increases.

Geoffrey Spence: A lot of this investment may sound like operating costs, but it is not. Maintenance CAPEX can be quite significant amounts of capital investment, which is equivalent to a similar piece of new investment, particularly in the case of water companies where there are a large number of projects of a similar size, whether it is new CAPEX or maintenance CAPEX. In characteristics, it often is the same as CAPEX.

The other important point to make is that the alternative is that you pay as you go. In other words, as the costs arise, you pay for those directly. What that would do is to put up bills, and put them up very significantly. In terms of the water industry, by multiples of-

Q287 Chair: Bills are going up anyway, Mr Spence.

Geoffrey Spence: They would go up even further.

Q288 Chair: Do you know that? I bet you do not even know that.

Geoffrey Spence: Yes, we do know that.

Q289 Chair: Have you modelled that? Can you show us?

Geoffrey Spence: We could show you it, but it is basically just taking the maintenance CAPEX, by way of a capital amount, and adding it to everyone’s bill in the year in question. Another point about this is that that facility-that investment-will be there for 30 years. Even though it is maintenance CAPEX, it is an investment and it will be there for 30 years. There is an equitable point, which is that that should be paid for over the life of the asset, not by consumers today on behalf of consumers in 20 years’ time.

Q290 Chair: Do you know, Mr Spence, whether the notional cost of capital across all this infrastructure reflects the real cost of borrowing?

Geoffrey Spence: I cannot speak for every water company-

Chair: Or energy company.

Geoffrey Spence: Or energy company, but it is the case that when you look at the average cost of capital from the private sector side, it does equate to what these regulators set in their periodic reviews. If you look at it from the City’s point of view, the average cost of capital to these firms equates to what the regulators come up with as the actual cost.

Q291 Chair: I find that really hard to believe from the evidence that I have got. It seems to me shocking-I have to say that to you, Mr Kingman-that this is not monitored.

Geoffrey Spence: It is monitored.

Bronwyn Hill: It is.

John Kingman: It absolutely is monitored.

Q292 Chair: Well, when I asked you all whether the notional is anywhere equivalent to the real, you could not answer me.

John Kingman: This is central to the role of the economic regulators. They emphatically do monitor it-that is their job. Geoffrey has given you our sense of it across the piece.

Q293 Guto Bebb: I want to follow up on the description of capital versus maintenance. I am a Welsh MP, and obviously Welsh Water has an interesting ownership model. It has just announced below inflation increases for the next five years, which most of my constituents will welcome. In my constituency, a replacement pumping station is being built and a new underground reservoir complex is being developed. I suspect that I would treat one of those as maintenance and one as capital spending for a new project, but would that be too simplistic? I am trying to understand the point you were making about maintenance versus capital.

Geoffrey Spence: What I really want to say is that capital expenditure is different from operating costs.

Guto Bebb: Okay.

Geoffrey Spence: The second point I want to make is that if you just add that up over a periodic review on a pay-as-go basis, it will put up bills by a very large percentage in that five-year period. You therefore do not get the benefit of lower bills from switching to a different model.

Q294 Guto Bebb: So you have not got a hard and fast way of looking at these issues; it is more to do with the long-term performance of an asset, which is then renewed, in effect.

Geoffrey Spence: Yes, and if it is maintenance CAPEX, that piece of capital expenditure probably has a long-term life and that is probably accounted for in the water company’s books. I do not know what it would be-perhaps 10 or 30 years; it depends on the type of equipment. That is what capital is and that is why it should be financed on a long-term basis, and that is cheaper for the consumer. It also spreads the cost throughout the life of the asset for those who use the asset, which means that you avoid some of the inter-generational cost that would arise otherwise.

Guto Bebb: I should say that obviously I am not criticising Welsh Water at all.

Chair: I just wonder whether you monitor whether it is all genuine capital. I bet it is not.

Q295 Austin Mitchell: I want to pick up on the point made earlier about the inability to tell us the effects, over a specific period, of the increases on the most vulnerable groups. The shifting of the cost of infrastructure on to increased energy prices in particular creates a need for some kind of protection or subsidy for the less well-off groups.

We have a submission from National Energy Action that makes the point that additional funds are much needed to provide for increasing investment in energy efficiency for low-income households, because millions of the poorest consumers’ energy continues to be wasted through leaky roofs, walls and inefficient heating systems. It cites the independent review on fuel poverty, led by Professor John Hills, which illustrates the fact that current resources fall far short of what is required to protect the health and welfare of the fuel poor because of the need to address our ageing and thermally inefficient old housing stock. Yet, the resources going to funding for solid-wall and hard-to-treat cavity walls under the energy company obligation has been cut, and there are fears that many social housing projects are now being re-profiled, or stopped altogether.

Secondly, it is expected that the levies on energy consumers will fall particularly on the low-income, private tenant households. Given the steady increase in costs and bills to provide for an infrastructure that has been neglected in the previous period, what consideration has been given to protecting particularly the poor and giving them some kind of compensation, because energy inefficiency is greatest in those poor households? I’m sorry, that is a long question!

Simon Virley: There is no doubt that fuel poverty is a huge long-term challenge. You referred to the Hills review, which has helped us to get a better handle on the scale of that challenge in terms of the new definition of what it is to be in fuel poverty. The Government have a series of measures to try and address the issue. The warm home discount helps 2 million low-income households. The ECO scheme, which you mentioned, has a fuel poverty element in terms of affordable warmth. There are, of course, winter fuel payments, cold weather payments and the rebates that were announced before Christmas.

So there is a lot of work under way to try and address the issue now. Nobody is underestimating the scale of the challenge, and the Government is looking afresh at its fuel poverty strategy in terms of the new definition that John Hills has provided, and it will bring forward further plans this spring for what it now needs to do going forward.

Q296 Austin Mitchell: When can we expect to see the fruit of that work, so that we can assess the scale of the problem?

Simon Virley: This spring.

Q297 Chris Heaton-Harris: Volume I of the Report states: "Government has made no assessment of the overall impact of infrastructure on future bills or whether those bills will be affordable." How is the Government addressing that?

John Kingman: We talked about this earlier.

Q298 Chris Heaton-Harris: Okay, forget that; I’ll read it in the transcript later. That is absolutely fine.

Did you talk about whether new infrastructure would be fit for purpose for the whole of its expected life? The NAO recommended that Ofgem and Ofwat should assure themselves that in future new infrastructure will be fit for purpose for the whole of its expected life. Where are you on that?

Geoffrey Spence: I think that is an evaluation that would be done. It would be great if there was a bit more detail as to the concern in this area. If it is projects funded directly by the Government, that is a key part of the evaluation that would be done by a Government Department using Green Book principles. If it is a regulated industry, there would be a key part of what a regulator would look at-whether this investment is needed, and will actually be needed over the right time and therefore available.

Q299 Chris Heaton-Harris: The Renewable Energy Foundation did a report into how long wonderful wind turbines last. Onshore tends to last about 11 years-predicted to last for 25-and offshore is in a much more unpredictable environment, with salt thrown into the mix. When you are setting objectives that are meant to last 25 years, investing in or subsidising pieces of kit that last only 11-ish years, how does that fit in with the recommendation by the NAO? Or do you say that that is one for the companies to worry about?

Geoffrey Spence: In many cases, it is for the companies to worry about. If they have made an investment, they will have an expectation of life cycle costs. Maintenance can go up quite heavily; perhaps a piece of kit has degraded to a far greater extent than was expected because it is offshore. That risk-whether the kit will need extra costs-is left, particularly in the energy sector, with the private sector.

Q300 Chair: Mr Spence, I must challenge that, because this afternoon’s thing has been that the risk is not with the private sector. The risk goes on consumer bills. There is a bit on this in the Report. We have the ghastliness, as Chris was talking about, of the transmission of offshore energy into the grid: they were signing 20-year contracts for turbines that lasted only 10 years, with guaranteed income to those who won those particular contracts. It is one of the most dreadful contracts the Government signed, but it does not end there. The Report also tells us that consumers are expected to pay for the new infrastructure, but you don’t even check that the companies have built the infrastructure to the specification agreed, because you are getting more light-touch. Page 10, para 17: the whole risk is on the consumer.

Geoffrey Spence: When we are talking about offshore wind, which is what the example was about, that is left with the company. Under the support they will get from a contract, the difference is that if they do not generate, they do not get paid.

Chris Heaton-Harris: But we have invested in the connection.

Chair: Quite.

Q301 Chris Heaton-Harris: My contention is that these things don’t ever get to the load factor that is predicted in the first place. They are over-subsidised, which is why they are being built. In fact, we had testimony to that effect from the guy from npower in the first evidence session. The subsidy arrangement has skewed things so much that they were just investing in onshore, rather than the obvious choice, which was gas. We are connecting these things to the grid. They are not producing the energy. You are saying that they get hit, but if you look at the DECC report into how much money goes into the infrastructure to connect these things to the grid, whether they are offshore or onshore, that is picked up by the consumer for ever, is it not?

Simon Virley: Yes. The grid infrastructure would reflect the pattern of development, but I think the point that Geoffrey is making is that there will be a commercial incentive on the developer to maintain that asset to ensure that it is there for-

Q302 Chair: Why?

Simon Virley: Because they have a subsidy that is available to them for 15 years. They will have done their business case on the basis, no doubt, of maximising the return they can under the subsidy rate that they have for 15 years.

Q303 Chair: But under the current regime, they can then come back and say, "Actually, we need new infrastructure investment. We will do a new plan for you, which you will go through your regulators. You don’t really care about the affordability, and the consumer will pick up the bill." If it lasts only 10 years, they may lose out a little bit of subsidy, but they can come back with a new infrastructure plan, which you will not assess to see whether it is affordable but gets palmed off to the consumer.

Simon Virley: We would be very surprised if this infrastructure lasts only 10 years on a regular basis.

Q304 Chair: But there is nothing to stop them. You talked about incentives in the private sector. I just don’t see it in this model.

Geoffrey Spence: If they invest in an offshore wind platform and in 10 years the life is over, they have lost all their initial investment in terms of the return they would otherwise have got.

Q305 Chris Heaton-Harris: But the subsidy is so high that they don’t have to worry about that, because they have gained it all back in three.

Geoffrey Spence: I haven’t heard many investors say that they are going to get it back in three. I haven’t seen any projects where they are gaining it back in three.

Simon Virley: Surely if there is a high capital cost, like an offshore wind farm, you will want to run it as long as possible. Because your marginal operating cost is extremely low, your sunk costs have been made, so you have a commercial incentive to keep the thing open as long as possible.

Amyas Morse: In making this recommendation, our reason is simply that, generally, if there is collective optimism in the sector, we generally find that the Government end up paying for it. You are quite right, of course, that if you are an individual company and you make a foolish decision and your plant gets worn out in advance, you lose out. Clearly that is right at that level, but it is not the same if there is collective optimism in the sector and you suddenly discover that; and then when the risk gets bigger, it tends to come back to the Government.

So we make a modest proposal only, which is that whatever apparent useable life is being adopted-which should be true in accounting terms anyway-the regulator should be very sure, and perhaps quite challenging, in accepting that that useable life is genuine and realistically maintainable, and on a convenient way of producing a better return with lower depreciation in the short term.

Simon Virley: Indeed; Ofgem, for example, have specified outputs for the transmission companies in terms of the grid infrastructure and in terms of the subsidies we have for renewable energy projects. We also specify the outputs that they have to generate in order to get the subsidy. So it is not as if the Government simply hand the subsidy over and do not then do anything in terms of monitoring and evaluation of those projects.

Q306 Mr Bacon: But the point is articulated perfectly in paragraph 3.9: "Regulators’ approach to scrutinising infrastructure projects that consumers pay for differs from the government’s approach to scrutinising capital projects that taxpayers pay for. Taxpayer-funded capital projects are expected to receive individual detailed scrutiny."

Obviously, consumers cannot engage in the individual detailed scrutiny that the Government do for taxpayer-funded projects. They expect the regulator to do that for them, because they cannot do it, but you do not. This says very clearly that your approach differs for projects that consumers pay for. There is a lighter touch. That is the problem.

Simon Virley: I was saying in my earlier answer that there is a mechanism to monitor the outputs in terms of the regulated parts of the network done by Ofgem. Indeed, in terms of the subsidies that the Government offers, there are specified outputs of those contracts too. It is not as if there is no monitoring and evaluation of these projects.

Mr Bacon: I didn’t say there was; I said it was much lighter touch.

Q307Chair: Do you have a view between you on an acceptable rate of return for a water company?

John Kingman: No, that is what we employ Ofwat to do.

Q308Chair: Do you have a view? Presumably Ofwat reports to you.

Bronwyn Hill: They are accountable to Parliament as a non-ministerial department.

Q309Chair: So you don’t have a view.

Bronwyn Hill: I don’t have a view. Well, I don’t duplicate what Ofwat does.

Q310Chair: We think you are all responsible for affordability, but you do not have a view on an acceptable rate of return. Do you have a view on energy?

Simon Virley: No, because Ofgem is the independent regulator responsible for that.

Chair: We will bring this to an end; I am not sure it is worth going on with it. The whole problem with this hearing is that I fear you are going to force us to conclude that there is a real vacuum in anybody taking responsibility for these massive hikes in people’s energy and water bills and looking at whether they are affordable enough in the round, or particularly unaffordable to the poorest in our community. That is just not acceptable. Passing the buck to a regulator here and refusing to collect information there is a terrible state of affairs in an area which is so important in how people spend their money and in keeping the lights on. It is just madness. We are in a mad position.

Chris Heaton-Harris: I am sure you talked about this in the fuel poverty bit, but DECC’s assessment of how people will benefit from all this is based on them buying new white goods. If you are in fuel poverty, you are highly unlikely to be able to afford to do anything like that. Actually, we have somehow managed to find a strategy that rewards people who can replace old white goods with top-notch new ones, but unfortunately penalises the poorest in society. However, I just wanted to ask one more question about Eggborough, which I know is an ongoing concern and discussion within DECC.

Chair: We’ve talked about this.

Chris Heaton-Harris: Well, I’ll go away from that as well, and I will read the transcript. Never entertain constituents; always come to Public Accounts Committee meetings.

Q311Mr Bacon: Mr Virley, for the record, I have been with a constituent as well, but I managed to get the point about Eggborough. Can you reprise what you said about DECC? I forget the exact phrase you used, but it was about doing the maximum they can in terms of return on capital within what the regulator set. Is that right?

Simon Virley: I am saying there is a commercial incentive, because of the high capital cost of much of the power plant that will be invested in, for them to keep these plants open. The example that was given earlier was that an offshore wind farm might stop running after a few years, but I was pointing out that there would be a commercial incentive for them to keep operating, because there is a low marginal cost of operating that plant and there is a high capital cost. So there would be a commercial incentive to continue operating that wind farm.

Q312Mr Bacon: But I think you said something else about them getting the largest return they could.

Simon Virley: Well, I am sure they will be seeking to run that wind farm in a way that makes sure that their outages, for example, are not on windy days and that they maximise the power that they produce at times when they can maximise their returns. They have choices about how they maintain those wind farms, and that is what I am sure they will be seeking to do.

Q313 Mr Bacon: This is really a question for Bronwyn Hill. Last autumn the Environment Secretary wrote to water companies asking them not to impose a series of increases in tariffs from this coming April, which had already been agreed under long-standing formulae. Are you as a Department expecting the water companies to do less than maximise their return?

Bronwyn Hill: No.

Q314 Mr Bacon: You’re not. Because I don’t understand why that request would then go in. If Ofwat had already made this determination and there were long-standing formulae upon which the tariff rises were agreed, why would your Department then intervene and ask water companies to accept a lower rate of return? I don’t understand that.

Bronwyn Hill: Because an annual tariff is also set within the five-year price cap, so there was an opportunity to point out to companies the affordability issues for constituents and consumers, and a lot of them took account of that in setting a lower price for the final year of what is the current five-year period.

Mr Bacon: I see. Thank you.

Chair: Right. Thanks very much indeed. That’s it. I am sorry it was a bit of a case of people in and out.